Credit Unions have a desire to help their members in this time of crisis by offering skip-a-pay and forbearance options as an easy way to help bridge members through a temporary crisis. However, is this a temporary or a long-term crisis? Economists are conflicted in their projections of America’s recovery timeline. Some say the recovery curve will look like a V, others are slightly less optimistic and say the curve will be U shaped, while others are anticipating an L shaped curve with long term consequences extending for five to ten years. The truth is that it is too soon to know.
The primary reason members are requesting to miss loan payments is related to their unemployment. The unemployment rate as of April 30th is at 14.7%, a 234% increase from March, and there are some predictions it could be as high as 25%. Many of the members choosing to skip loan payments or asking for mortgage forbearance could have an uncertain employment situation in both the short and long term.
As can be seen in the graph below, prior to the great recession the unemployment rate and the charge-off rates were 4.4% and 0.44% respectively. During the peak of the great recession unemployment crested at about 10% while charge off rates tripled to 1.2%. If this ratio holds true, then at current unemployment levels of 14.7%, , it seems reasonable to extrapolate that if the economy doesn’t recover quickly charge-off rates could approach as high as 1.8%.
According to the Mortgage Bankers Association, mortgage forbearances represented 0.25% of all mortgage loans as of March 2nd. As of May 3rd forbearances represented 7.91% of all mortgage loans. Mortgage forbearances can be especially concerning if the loan is not modified in a manner such that the missed payments are added to the end of the term. Few borrowers would be able to make multiple mortgage payments at the end of the grace period. Forbearances, and even more importantly, skip-a-pay’s on other loan types can create “hidden delinquency” that would be unseen by the credit union for several months. For example, if a member paid their loan in March, then became unemployed and skipped April, May, and June payments with next due in July that member would not even be on your 30 day delinquency until August. It’s possible, for this reason, we could be creating a recipe for a spike in foreclosures and/or loan delinquency in the next six to twelve months.
We are all familiar with skip-a-pay programs. Many credit unions offer them to members on a regular basis. Members take advantage of them and generally there is little to no harm to the quality of your loan portfolio. But this is a different economy and a different reason for skip-a-pays. Do we know what is going to happen with this different group of borrowers? Are we delaying the inevitable? There is no known set of rules to determine how these loans will perform and you need track them to assess performance throughout their life cycle so you can understand how they will perform for your credit union.
So, then we must ask ourselves, are we kicking the can down the road on both our delinquency and charge-off loans by allowing missed payments? We may be delaying the inevitable to some degree. Being prepared to understand how this will impact our credit union can go a long way in ensuring the strong financial future of the credit union for its members. Yes, to some degree it is kicking the can and that’s acceptable because of the value proposition Credit Union’s provide to their members.
Per NCUA guidance related to modifications. they will likely be reviewing your process related to these loans. NCUA’s guidance (NCUA 20-CU-13) is as follows: Success is measured by the performance of a loan after it has been modified. Effective credit risk-monitoring practices should include periodic reports to the chief executive officer and the board of directors on all modified loans, support a successful collection process, and ensure the prompt recognition of loan losses. A credit union’s monitoring practices may include reports of the following:
- Number and volume of modifications, by loan type,
- First payment defaults,
- High loan-to-value and debt-to-income ratios,
- Credit quality,
- Number of times each loan has been modified, and
- Expected loss exposure.
As you already do with modified loans by reserving additional funds in your Allowance for Loan Loss, you should consider proactive preparation and reserve additional funds for loans with modified payment terms under these circumstances.
2020 Analytics was founded during the great recession to help Credit Union’s understand loan portfolio risks. We understand the challenges created by wrangling your data and we are experts in how data can be used to improve your business model. 2020 Analytics can help you understand the risk in your loan portfolio and help you be able to quantity, track, and mitigate the impacts your Covid-19 outreach programs can have on your loan portfolio. Feel free to contact us and we can discuss options that best fit your needs.